Portfolio builder: Collector's edition

Commentary: Meet an investing expert who owns 62 mutual funds

BOSTON (MarketWatch) -- Don Phillips, managing director and president of fund research at investment researcher Morningstar Inc., told me in the mid-1990s that investors could effectively build a portfolio using between five and 12 mutual funds.

At the time, the Morningstar
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style box -- which classifies funds by investment style and asset type -- was becoming a dominant force in the fund world, and diversified investors were thinking they needed to fill every box several times to spread their money around correctly.

Phillips, however, did not seem to be living his own advice, as his personal portfolio then included about two dozen funds.

So I revisited the question with Phillips from the stage of the Morningstar Investor Conference in Chicago last week, as part of the fund research round table, and his answer was shocking:

Phillips has 62 mutual funds in his portfolio. That's no typo. Five dozen -- plus two.

The reaction from the crowd was that Phillips, one of the most powerful figures in the financial services industry, doesn't have a portfolio -- he has a collection.

Find a balance

But Phillips also acknowledged another approach -- that just one fund can be enough, "if it's the right one."

And somewhere between the minimalist one-fund-is-your-portfolio approach and the hobbyist's massive collection is the right number for the average investor.

Ironically, in finding that right number, you can learn from Phillips' experience, because while 62 funds sounds like a mess, there's a method to the madness.

For starters, Phillips didn't actually pull the trigger on all 62 funds. A Morningstar Associates program picks funds in one plan he is involved with, and Morningstar Investment Services picks the issues he holds in a mutual-fund wrap account.

In each case, Phillips wanted to taste the home cooking, and the company's decision-making programs picked 27 of the funds he currently owns. Still, that leaves 35 funds on which he makes investment decisions.

Obviously, as a top dog at a large, successful financial company, Phillips isn't hurting financially. Roughly one third of his personal portfolio is in Morningstar stock and stock options and the like. Another third is in bond funds, and here, Phillips is no collector, using just four low-cost Vanguard funds to get the job done.

"Morningstar itself is heavily tied to the equity market, so when I started diversifying -- and I admit I should have done that sooner -- I wanted low-cost bond funds, because costs matter in bond funds probably more than anywhere else," he said.

Phillips follows similar thinking with the last third of his assets -- the stock portion. There - among 31 funds -- is a core portfolio of low-cost Vanguard index funds and some exchange-traded funds based on Morningstar indexes (more home cooking), which cover the basics.

After that, however, comes the collection -- a mix of famous names and managers:

There's also Templeton Growth
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the first fund Phillips ever owned, the shares a gift from his father, which he acknowledges keeping mostly for sentimental reasons.

About four years ago, Phillips consolidated the bulk of his holdings into Vanguard's fund supermarket platform. He sold some Fidelity funds at the time -- frustrated by frequent management changes -- but says he mostly would get rid of a fund only if the manager changed and he didn't like the new head honcho. Most funds in the collection part of the portfolio are owner-operator funds run by famous managers.

"I have tried to align these funds with what I do with Morningstar, taking part in the programs that Morningstar offers, and then buying funds that we give high ratings to our where we showcase the managers at our conference," Phillips said. "Warren Buffett says he buys businesses and his favorite holding period is forever. Well, I buy funds that I want to own forever too.

"If you go in with that 'forever' intention, it makes the hurdle that much higher and makes it much harder to add a fund to your portfolio," Phillips added. "You're not going to buy the manager of the week or from the fund firm that keeps changing strategies. You can stop after just a few funds, but those will be the funds that you are confident will do the job over your lifetime."

Choose with care

While Phillips' collection is eccentric, his plan is not. It starts with a strategy -- one that included eliminating debt before beginning an aggressive savings plan -- that is implemented through a diversified portfolio of stock index and muni-bond funds. Only with those things in place is there room for what, for Phillips, is "fun money."

For some investors, a basic stock-and-bond strategy could be as simple as one fund, Phillips said, either a target-date portfolio that ages with the investor or a highly diversified balanced fund like Vanguard Wellington or Wellesley.

Expanding the portfolio from the one fund -- but sticking with the overall investment strategy -- will lead to a number of funds you can be comfortable with -- and not 62 of them.

Said Phillips: "I have complexity in my portfolio, but it's by choice -- and because of my interests and my job -- and not because something crept in there by accident. If someone starts with a strategy and then finds funds to achieve it -- and can remember that they're investing for life and not for last year or right now -- they'll find the right number."

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